Importing Goods from China? Consider Purchase Order Financing
Many small and startup importing companies have been able to grow - often dramatically - by adopting the strategy of importing goods that are manufactured in China to sell them in the US or Canada. Basically, they receive a large purchase order from their US or Canadian client and then place a corresponding order with the Chinese supplier to manufacture those goods. However, few Chinese suppliers extend trade credit and will often demand to be paid with a letter of credit before production begins. Small import companies can run into problems because most banks will only issue a letter of credit if you can provide them with collateral - either cash or through a line of credit. If you don't have the collateral, you won't be able to get the letter of credit.
Letter of credit alternatives
One way to overcome this issue is to use supplier financing to cover the letter of credit. Basically, you can use your purchase order as collateral for financing. The finance company uses this as collateral and issues the letter of credit on your behalf. This enables you to buy the goods from your supplier and deliver them to your customer. The transaction concludes when your customer pays for the goods on their usual terms.
Does your order qualify?
To qualify for this type of funding, your purchase order must meet the following criteria:
- It must have a minimum gross margin of 20%
- It must be for finished goods only
- Your foreign supplier must accept a letter of credit as payment
- Your end customer must have good commercial credit
- Your foreign supplier must have a good track record
Additionally, your receivables must be free of liens and your company must have a track record of delivering the products that you sell. However, this solution is available to startups and new companies that have a limited track record.
How is a transaction structured
Most purchase order finance transactions are structured by working with a finance company that issues the letter of credit on your behalf and settles when your client pays. The transactions often follow these steps:
- You receive an order from a credit worthy customer
- You place an order with your Chinese supplier
- The factoring finance company issues a letter of credit
- Your supplier manufactures the goods, sends them through inspection and ships them
- Your client pays 30 to 60 days after receiving the goods
There are two ways to settle the transaction. One way is to simply leave the transaction open until you end customer pays on their usual terms. However, you can often reduce the total cost of the transaction by also using a factoring line. You can factor the invoice as soon as the goods are delivered to your customer and then use those proceeds to close the po financing line. Factoring lines have a lower cost than conventional supplier financing lines, which results in lower total costs.
Third party inspections
One of the requirements that will be put in the letter of credit is to have a third party company inspect the goods to ensure that they comply with your specifications of quality and quantity of your PO. This helps ensure that the supplier delivers the goods that they were contracted to manufacture. There are a number of companies that can be used for this service and is fairly common in the industry.
Advantages and benefits
The most important advantage of financing purchase orders is that the line is flexible and has no high limit. The size of the line is determined by the size of your order, the credit quality of your end customer, the track record of your supplier and you ability to execute the order. Additionally, a key benefit of po funding is that the line can be setup relatively quickly, often in a week or two. This makes it an idea solution for importers who got an unexpected (or expected) large order and need financing to cover their supplier expenses.
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